If you are interested in buying a franchise, you want to see Item 19. If you are selling a franchise, you may be worried that’s all they’ll see. Item 19 can clarify or muddy the big picture.
For those who don’t know, Item 19 is the section in the franchise disclosure document (FDD) that provides a financial performance representation and helps you understand how much money you can make as a franchise owner. An FDD is a document that explains the history of the franchise, all related fees, any litigation involving the franchise, rules and regulations, and basically anything you’d want to know about a franchise. The Federal Trade Commission requires franchisors to give the FDD to a prospective franchisee at least two weeks before they sign the contract.
But while the FDD is required by law, Item 19 is not.
Of course, it may sound improper to suggest that Item 19 shouldn’t be in an FDD. This could make it seem as if the franchisor (and the master franchisees, if they exist) is hiding something. But I believe there are actually a lot of ethical reasons to leave the Item 19 out, and prospective franchise owners need to be aware of that before they rush through an FDD in search of Item 19. What you’re seeing in writing is not always the full picture.
So, if you’re wondering if you should include an item 19 in your FDD, you can make good arguments either way. But here are some reasons why you shouldn’t.
Item 19 can make financials look better than they are.
Let’s say that your franchise only has locations in extremely busy cities so far where you’re going to get a lot of foot traffic no matter what.
But now you want to go into rural areas, where you’ll still get a lot of customers, but maybe the profits aren’t as likely to be anything near what you’d make in New York City or Chicago. If you’re basing the financials off a busy city, and you don’t yet know how your location will fare in a suburb 30 miles outside of a major city, you can start to see how Item 19 might paint way too rosy of a picture.
Sure, it’s true that some franchisors are sometimes squeamish about revealing how much a franchise owner might make because they worry that the profits may not look appealing enough to prospective buyers. But if you’re a fairly young franchise that’s still working on figuring out what profits are likely to look like in different parts of the country or world, you often simply don’t know how well a new location will perform.
Another thing to consider: if you have several company-owned franchises, those might bring in more profits than franchises the corporation doesn’t own — at least in the beginning. The company-owned franchises sometimes have more management experience than the newer franchisees, and that, too, could skew numbers.
Just as you may not want to undersell the potential to make profits, you certainly don’t want to oversell the potential either.
Item 19 may offer the franchisee an incomplete financial picture.
If your franchise is in a lot of cities, you could nonetheless extrapolate an idea of what the franchise will make when there are locations in rural areas. But what if your franchise is selling its first or second franchise?
Again, you can put a range of numbers in Item 19 of what you expect a franchisee to make, but you really may not know for certain. One reason franchisors might not put those financials into Item 19 is that they’re afraid of being held liable for that information.
Item 19 can create unrealistic expectations.
This is similar to what I’ve already said, but Item 19 information can be especially problematic and tricky when you’re expanding worldwide. In a country halfway around the world, you might be offering different products and differently sized locations — and, of course, what you pay your employees will likely be different.
You may be confident your franchise will work overseas — and fully confident that your international franchise owners will be as profitable as your domestic franchise owners — and still not have a grip on exactly how profitable you expect owners to be.
Item 19 is meant to offer clarity to prospective franchisees, but sometimes it can offer anything but that. Of course, franchisees need to understand how much money they should expect to make, and that’s a discussion I believe you, or your master franchisees, should have with prospective franchisees.
But at the same time, I’ve found that including Item 19 in a franchise disclosure document can cause a lot of misunderstandings because weirdly enough, it’s not always an accurate representation of potential financial performance. For instance, current Item 19s aren’t always standardized. If you look at them from franchisor to franchisor using search tools such as the Wisconsin Department of Financial Institution’s, you’ll see that they often differ. Eventually, the FTC might mandate that all franchisors have an Item 19 — and I expect that would be fine because, at that point, there will be clear rules for how an Item 19 should look.
So, of course, if you’re a franchisee, you might think, “OK, I can’t necessarily trust an Item 19. How do I know my franchisee income level?”
Really, I believe the best information comes from the franchisor — and existing franchisees. If you’re really serious about buying a franchise and you want to see the big picture, I’d suggest contacting franchisees around the country in similarly sized cities to your own. Talk to at least a few to see if they’ll share some of their financial data — as well as the level of support, backup and guidance the franchisor has provided them, which is important information to have. Believe me: If you find franchisees who aren’t happy with the money they’re making and their franchisor’s support, you’ll get an earful.